Taxes: Pay them now or pay them later

With taxes, timing is everything. Paying them, and paying them on time, determines whether you will watch TV at home on your flat-screen, or in a large room with several hundred other people dressed in orange jump suits. Your choice!

Since the late ’90s, there has been a way to pay up-front so that when you retire, any nest egg you have built up will be tax-free. It’s called the Roth IRA.

Now that the Roth pre-tax option has been added to the federal Thrift Savings Plan, many workers wonder whether they should have a Roth IRA outside of the federal 401(k) plan, or whether to open a Roth TSP account.

The advantage of the Roth is that its funded by after-tax contributions. What that means is that 10, 20 or 30 years later when you cash in your account (Roth IRA or Roth TSP) all of the money is yours. Tax-free, too — as long as you meet the IRS requirements.

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With a regular IRA or 401(k) plan (like the TSP) both the employee and employer contributions are pre-tax. That gives you a temporary, and often very badly needed, tax break each year. But when you cash in the regular 401(k) or IRA, the entire amount is subject to taxes. Some people prefer the immediate tax break. Many also feel that their taxes will be lower when they retire because their income will be less. Others think that taxes in future could be much higher, or they simply want an untaxed stream of income in retirement.

We got an e-mail last week from a 52-year-old Air Force civilian. He is contributing the maximum ($6,000) to an outside Roth but wonders if it would be better to convert it to the TSP Roth, “or are all Roth’s the same?” Good question.

If he’s a FERS employee and is asking whether it is better for him to contribute $6,000 to a Roth IRA or $6,000 to a Roth TSP, he should be aware that his contribution to the Roth TSP will be matched by his agency’s employer contribution.

In addition, Weaver provided this fact sheet and this Q&A on the Roth TSP.

It sounds like he wants to transfer his Roth IRA to the Roth TSP? If that’s the case, he isn’t able to do that.

But, if he is asking if he should contribute to a Roth IRA or the Roth TSP, then, as Kim said, he will get matching on the TSP if he is FERS. If he is doing this above the 5 percent that is being matched, then the TSP also has low administrative expenses compared to investing the money on his own. The IRA has more investment options besides the G, C, F, S, and I Funds. I would probably choose the TSP for its low cost and simplicity, but he may like to diversify into different types of investments.

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